Taxand Predicts UK Emergency Tax Budget Outcomes

In a historical benchmark, for the first time since 1945, no party won an overall majority following the UK elections earlier this month. The resulting negotiations led to a new Conservative Prime Minister, David Cameron, and a new Liberal Democrat Deputy Prime Minister, Nick Clegg.

Taxation is one of the key areas for debate between the two parties as it is a crucial tool in addressing the country's budget deficit estimated at GBP165bn this year. The detail of exactly how tax will be used to help to address the deficit will be set out by the new UK Chancellor of the Exchequer, George Osborne, in his emergency budget which will be presented to parliament on 22 June 2010. It seems likely that some if not all of the following proposals will be implemented:

introduction of a new bank levy which, if pre-election Liberal Democrat statements are to be followed, will be 10% of banking profits. The devil here will be in the detail, particularly in how profits are defined with respect to the much criticised banker bonus payments

a rise in value-added tax (VAT) from the current 17.5% (a 2.5% increase in VAT to 20% would increase revenues by about GBP 12bn a year)

an increase in the capital gains tax rate, currently a flat rate of 18%

a reduction or elimination of the tax free capital gains personal allowance, currently GBP 10,100

removal of higher rate tax relief for charitable contributions

the cancelling of the 1% increase in employer National Insurance contributions scheduled to take place next year

a new airline tax on a "per plane basis" based on carbon emissions rather than the current passenger duty

simplify and reduce the rate of corporation tax, through the stepped reduction in the headline rate or the continuance of reliefs so that it becomes the lowest rate within the G20 nations

reform of the controlled foreign companies rules that are aimed at stopping tax avoidance but which have actually driven businesses overseas

an increase in the income tax allowance to GBP 10,000, but is likely to have to be phased in over a number of years

The rise in capital gains tax has attracted much attention, not least because tax advisors are looking for opportunities for individuals to crystallise gains now. The remainder of this alert will consider the impact of the potential changes to capital gains tax, VAT and employment taxes.

Capital Gains Tax
The Coalition Agreement of the newly formed UK government makes reference to their stated ambition of cutting personal allowances on income tax for those on low and middle-incomes by raising revenues from "taxing non-business capital gains at rates similar or close to those applied to income, with generous exemptions for entrepreneurial business activities."

It is not surprising that the gap between 18% capital gains and 50% income tax is to be reduced, even if not fully closed. For ease of administration, as well as historic precedence, the betting must be on rates and thresholds matching those of the new income tax rules. If this is the case it seems very harsh to also remove the annual tax free allowance. However, if the Conservatives get an agreement from the Liberal Democrats to eliminate the tax free allowance for 50% tax payers then this will be an easy win for David Cameron. The most complex option, and therefore not something to be recommended, is to have a declining allowance as cumulative income and gains increase.

There are numerous tax planning ideas to minimise the expected impact of the proposals currently being suggested by personal advisors to high net worth individuals. The most obvious idea is to dispose of assets now to crystallise the gain in the lower tax regime. However, care must be taken as there is a recent history of retrospective tax changes, particularly where they have been sign posted (the removal of higher rate tax relief from pension contributions for example).

The most interesting aspect of the proposals, however, will be the relief given to entrepreneurs. In particular, attention will be paid to whether private equity and venture capital funds will qualify for any relief

VAT
A rise in VAT looks almost inevitable according to economists. The issue for businesses in addition to the rate is the increased burden on companies who have only just recovered from the temporary decrease in VAT to 15%, which ended on 31 December 2009. Businesses are looking for stability as it is both disruptive and costly to keep reacting to rate changes. For this reason it is being suggested that a 19% or 20% rate is likely, however, there must be an argument for leaving other taxes alone and making a significant once and for all change in the VAT rate which could make a significant impact on the budget deficit in the very short term. Some have made the argument for a higher rate of perhaps 22% or alternatively to bring within the scope of a lower rate of VAT some currently zero rated items such as certain foodstuffs or children's clothing which might be taxed at 5% for example as is the case in many other parts of Europe.

Employment Taxes
In a not dissimilar way to VAT employers look for rate and tax treatment stability as changes to payroll systems are costly too. The fluctuation in income tax rates is not of itself hard to accommodate but, changes to the number of tax bands, the way the annual personal allowance is determined or the tax treatment of compensation elements are much harder to manage. The key is for employers and their payroll providers to be given sufficient time to make the changes to check their accuracy as mistakes become very costly quickly.

The change to social security is different since the tax increase proposal affected not only employee contributions but also employer contributions. Removal of the proposed 1% increase from 6 April 2011 for employer contributions (employee contributions are expected to still rise) will reduce employment costs; something to be encouraged where profitable recovery and job creation is needed to support the UK economic recovery. Cynically, it will also mean that the business economics for employment tax and national insurance planning structures and relocation of head offices overseas is less persuasive. This means that companies are less likely to adopt tax avoidance measures or to move overseas which would have otherwise reduced the government's overall tax take.

Taxand's Take

However, confirmation will only come with the final proposal details on 22 June. What is certain though, is that steps have to be taken to significantly reduce the budget deficit. The country can only wait and watch, as the financial tightening measures take hold.

Clearly these changes will impact multinationals operating in the UK. Businesses may choose to seek advice from their informed local Taxand advisor to ensure measures are being taken to mitigate risk and moderate potential unforeseen costs when operating and investing in the UK.